Property investors are in need of some retail therapy

Many would say that high street retailing is dead. The reality is that no high streets have truly perished and very few will be completely wiped out. Yet many are undoubtedly shadows of their former selves, most will never be the same again, and relatively few could be considered in fine fettle.

The global financial crisis sparked a severe downturn that changed consumers’ attitudes towards price and this coincided with rapid structural change in the retail sector. As a result, we reached the end of retail as we knew it.

The future will require less retail property and it will be distributed differently. For non-essential goods and leisure activities, consumers are gravitating towards a smaller number of shopping destinations. For property investors, this could mean there are fewer but better destinations that should remain resilient and are likely to produce a reliable income.

Nearly every consumer can now shop from the palm of their hand. Since the advent of 4G mobile networks, price comparisons have become clearer and consumers have become more technologically savvy. Retailers can make shoppers aware of products and appeal to their desires, but it is becoming more difficult to seal the transaction.

investing in the distribution hubs and giant warehouses that are vital for consumers in the new age of shopping

Relentless price transparency combined with cost-conscious consumers are damaging retailers’ margins. With gross margins under pressure, operating costs need to be cut. Retailers will use lease events (such as reviews and breaks) to get rid of weaker stores or to negotiate a sufficiently low rent to allow profitable trading. Landlords holding the UK market’s “excess” retail property face more pain unless they can find an alternative use. An ability to build on top of retail assets to create much-needed residential properties may be a valuable alternative. This would also create a local catchment for the retail and leisure assets that remain.

Retailers need to invest heavily in e-commerce or they will be left behind. Any predictions that e-commerce sales are plateauing have been unfounded, so far. Higher online engagement among younger consumers means that they will continue to support online sales growth. Even now, leading UK retailers, such as Next and John Lewis, generate around half of their sales online – and continue to see stronger growth in that channel than through stores – compared with less than 17% across retail as a whole. People are still buying goods; they are just doing it differently.

But while the retail sector is grappling with these challenges, the knock-on effect is a significant upside for industrial property. The structural shift towards e-commerce means that demand for warehouses and distribution hubs is outpacing supply in virtually all developed markets. But the pressure on land is high. Urban spread means that housing is being developed on brownfield land – new industrial sites are therefore scarce and competition is fierce, which is pushing industrial rents and land values even higher. A race for space has begun.

An innovative solution may be to transform existing out-of-town retail parks into a hybrid format. Shops could continue to trade from the front of the building, but behind the customer-facing operation, space could be developed for storage and distribution with transport access for urban delivery operations. As retail rents drop and industrial rents rise, the narrowing rental margins in many towns should support values.

The seismic disruption generated by e-commerce is well underway in the US and UK. But Europe is late to the party, which presents an opportunity for investors to be at the forefront of the transition and invest at the early stages. Rapid technology advances across developed markets and Amazon’s influence on every market it enters will also maintain the e-commerce momentum.

For property investors, investing successfully in the retail sector used to mean high streets, malls and retail parks. Now, and in the future, it is likely to involve a broader view: investing in the distribution hubs and giant warehouses that are vital for consumers in the new age of shopping.

The article above was previously published on Aberdeen Standard Investment’s ‘Thinking Aloud’ blog on 27th March 2018

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